May 15, 2018
BRUSSELS INSIDER #1 by Sonja van Renssen
EU gas market wants to be left alone
May 15, 2018
With work on a power market reform well under way, the European Commission has launched a discussion about potential reforms to the EU gas market after 2020. In a preparatory study, it identifies possible problems and solutions. But both within the Commission and amongst stakeholders there is limited appetite for another regulatory reform package at this point in time. Instead, the priority for the gas market today is how to facilitate the arrival of “green” gas.
In February 2018, the European Commission published a study called “Quo Vadis” on the functioning and potential reform of the European gas market. Senior officials suggest that an EU gas market reform could be one of the first pieces of energy legislation under the next Commission. The current Commission’s five-year mandate will come to an end in November 2019, so we’re talking here about a proposal in early 2020.
Klaus-Dieter Borchardt, Director for the Internal Energy Market at the Commission, said in an interview back in January that the bulk of this reform would be about creating a market for “green” gas i.e. power-to-gas and a broader shift away from natural gas. The basic idea is to give gas – a fossil fuel – a future beyond 2030 by decarbonising it. We covered the Commission’s thinking on this plus stakeholder ideas on the potential of hydrogen in particular in Energy Post Weekly back on 11 April.
The Quo Vadis study isn’t about “green” gas though. Instead, its 300 pages focus squarely on the state-of-play of the internal market for gas in Europe. The consultants who authored the study, Ernst & Young (EY) and an energy markets specialist based in Hungary, the Regional Centre for Energy Policy Research (REKK), pick out the “potential inefficiencies” of the gas market’s regulatory framework and discuss what policymakers could do to improve things beyond the Third Energy Package.
That Package, which will celebrate its tenth birthday next year, aimed to create a single EU market for gas and electricity, with the conviction that this is the most cost-effective way of ensuring secure and affordable energy supplies for all Europeans.
Risk of more fragmentation
On the whole, the EU has done better on gas than electricity when it comes to creating an internal market. “We have a functioning gas market,” said Borchardt back in January. “The market rules are more or less working.” The Quo Vadis study confirms this, noting the rise in market liquidity (though this is especially true for Western Europe), “intense” competition at the wholesale level and “moderate and converging” wholesale prices.
No need to worry about gas infrastructure either: “Given a moderate future gas demand outlook, the level of investment is generally sufficient in the sector.”
Nonetheless, the Quo Vadis study identifies and analyses several potential concerns: upstream market concentration (i.e. how much gas still comes from Russia), long-term capacity bookings and associated network access problems, the current level and structure of cross-border tariffs, and institutional constraints to market development and integration.
Significantly, “unless any regulatory or tariff change comes, we expect market segmentation to increase within the EU in the future,” the authors say. In other words, left alone, the EU’s internal market for gas is set to fragment, not firm up. That’s because with the shift away from oil-based long-term contracts to a spot market, capacity bookings are increasingly reflecting real costs and physical flows – and the bottlenecks and tariffs that underpin them. The study highlights the problem of “pancaking”, or the accumulation of tariffs when traders ship gas through several borders.
Current network codes and a “politically complex, slow and expensive” process to merge markets are insufficient to deal with these challenges, the study concludes.
Four regulatory options
The consultants analyse four alternative scenarios that could bolster the development of the EU gas market. This includes two variants of tariff reform: first, replace all intra-EU tariffs with a harmonised, higher EU entry/exit tariff, and second, do the same but at smaller scale, to create regional gas markets. Third, they look into an obligation for gas producers/importers to sell at least half their gas at the nearest virtual trading point and fourth, they fantasize about a greater integration of EU and Russian gas markets.
There’s little point going into the detailed results of each scenario, since none of them are likely to materialise any time soon. Rather, it’s worth noting that their appeal varies a lot depending on the boundary conditions. The modellers pitted each of their alternatives against a reference scenario and five sensitivity scenarios: high gas demand, an LNG glut, a high oil price and two different versions of Nord Stream 2 implementation.
So, for example, the EU-wide tariff reform does very well in more “turbulent” circumstances, such as a high oil price-low LNG-Nord Stream 2 gets built scenario. Overall, “EU welfare is highly sensitive to LNG supply conditions”, the authors note. The impact of Nord Stream 2 will depend primarily on Russia’s decision on how to continue using (or not) the Ukrainian transit system. The authors suggest that EU-wide tariff reform would do most to counteract the sharp price difference that Nord Stream 2 is expected to create between Northwest, Central and Southeast Europe.
Some of the scenarios have unexpected downsides. The more modest regional markets approach for example, could see its benefits undermined by the extra cost of infrastructure expansion in the merged zone and potential price increases in those countries just outside it due to new entry/exit tariffs. The risk of this approach is one of creating highly integrated zones with big barriers between them, the authors warn.
Their recommendation is the third scenario, which obliges producers/importers to sell at least half their gas nearby: “We conclude that the implementation of this scenario is a no-regret policy.” It increases competition in Central and Southeastern Europe, improves pipeline use, reduces prices and improves the situation in high-price countries without a corresponding decrease in low-price countries. Only this scenario, coupled with an LNG glut, could significantly reduce EU gas wholesale prices.
Except that is for more integration of EU and Russian gas markets, but that is “highly hypothetical” the authors acknowledge.
There is a caveat to all these results: the EU has yet to fully implement all of its gas legislation, including a new security of supply regulation decided last year. Nevertheless, the Commission clearly felt the current work was worth pursuing. And the headline conclusion is one that is unlikely to change any time soon: the future competitiveness of the EU gas market hinges first and foremost on the EU’s ability to manage its exposure to foreign suppliers i.e. Russia.
It’s hardly rocket science. And tariff reform is hardly a panacea. The study picks out LNG and “inter-fuel competition by renewable resources” as the weapons of choice in this battle. That explains why so much of this new reform package will be about facilitating the emergence of “green” gas. The Quo Vadis study may only mention it in passing, but the Commission has commissioned a separate study to make up for that.
Appetite for green gas, not new tariffs
Commission officials are careful to play down too much enthusiasm for tariff reform. “The outcome of the [Quo Vadis] study will always be useful for debate and discussions, but whether the time is right to go into legislation is on these outcomes is another question,” said Borchardt back in January. “I’m very reluctant now to make a big gas reform or invent a new gas target model.”
“The clear example is the tariffs question,” he continued. “Of course it would be good to have a common model for tarification. But I remind you of our discussion on the network code on tariffs.” That was a long, hard discussion and the code is only now starting to be implemented. “Coming then with a very harmonising proposal is maybe not the way to do it.” Nor does Borchardt believe that market mergers can be dictated by Brussels: “We have to let them grow.”
There is wariness too, among stakeholders, of launching a major gas market re-design. Alongside its Quo Vadis study, the Commission makes available a comprehensive list of stakeholder feedback on a series of related discussion papers. An organisation such as IOGP, the International Association of Oil and Gas Producers, cautions that it is “too early” to assess whether the rules in place, notably the network codes, are effective in creating an EU-wide gas market.
IOGP: “Early indications from the Northwest of the EU suggest that there are no apparent major issues and the market would benefit from a period of regulatory certainty. The focus should be on implementation of the agreed regulatory framework in the regions that are lagging… rather than redesigning the rules for the whole EU.”
There is more appetite for a policy framework to facilitate the decarbonisation of natural gas, to ensure its future beyond 2030. At a discussion on EU gas market reform organised by consultancy Fleishman Hillard in Brussels in April, under Chatham House rules, there were calls for the EU to become a leader in “carbon management”. There was great interest too in the Commission’s separate study to come on the electricity-gas interface.
Even before refining association FuelsEurope’s recent call for renewables-style support for “green oil”, there were calls at the Fleishman Hillard event for “subsidies” for green gas, a suggestion that “dedicated targets” could be a good idea, and even the notion that “those that benefit [from sector coupling, such as power-to-gas] should contribute to gas system costs”. Not a notion the power sector is likely to share!
To sum up, back in January Borchardt said he saw three main challenges for the gas industry in 2018. One, implementing the already agreed network codes. Two, making the case that it cannot be an “electricity-only” world. And three, embracing digitalisation. “In terms of optimising network operations, but also in terms of data management and linking that to new business models and opportunities in the retail market.” The gas industry has definitely picked up on one and two; number three still appears largely in the hands of its electricity brethern.